Chile: Selected Issues

This Selected Issues paper examines a number of potential factors that may have influenced the short-term behavior of the exchange rate between the Chilean peso and the U.S. dollar during the period of floating exchange rate, including the possible impact of developments in Argentina during 2001. The paper investigates whether copper prices can be successfully forecasted over medium-term horizons, emphasizing the properties of copper prices most relevant in the Chilean context, including for fiscal policymaking. The paper also provides a snapshot of the Chilean banking and corporate sectors.

Abstract

This Selected Issues paper examines a number of potential factors that may have influenced the short-term behavior of the exchange rate between the Chilean peso and the U.S. dollar during the period of floating exchange rate, including the possible impact of developments in Argentina during 2001. The paper investigates whether copper prices can be successfully forecasted over medium-term horizons, emphasizing the properties of copper prices most relevant in the Chilean context, including for fiscal policymaking. The paper also provides a snapshot of the Chilean banking and corporate sectors.

I. Overview

1. This paper presents four studies on selected issues of the Chilean economy. Chapter II examines a number of potential factors that may have influenced the short-run behavior of the exchange rate between the Chilean peso and the U.S. dollar during the period of floating exchange rate, including the possible impact of developments in Argentina during 2001. Noting the consensus that the prices for Chile’s copper exports will eventually recover from current, historically low levels, Chapter III investigates whether copper’s price can be successfully forecasted over medium-term horizons, emphasizing the properties of copper prices most relevant in the Chilean context, including for fiscal policymaking. Chapters IV and V provide a snapshot of the Chilean banking and corporate sectors, respectively, and highlight information on their strength by looking at key indicators.

2. Motivated by the large depreciation of the Chilean peso during most of 2001, and the high exchange rate volatility in the third quarter of the year, the chapter “The Short-Run Behavior of the Peso/Dollar Spot Rate Under the Free Floating Regime: Is there an Argentine Factor? Is there Evidence of Shift-Contagion?” analyzes the daily movements in the peso exchange rate during 2½ years of Chile’s floating exchange rate regime. The analysis is multivariate, controlling for a wide range of potential explanatory factors. The chapter also discusses the possibility of contagion from Argentina during 2001. In particular, it focuses on shift-contagion: whether the existing fundamental linkage between Chile’s exchange rate and Argentina sovereign risk suddenly and temporarily changed in 2001.

3. The study finds that developments in Argentina have influenced Chile’s exchange rate during 2001, but that this effect was smaller than suggested by simple bivariate correlations. During the sample period, the most important factor among those considered turns out to be Brazil’s exchange rate followed by Brazil’s sovereign risk. Although the possible causal relationships are difficult to disentangle, the evidence is consistent with the idea that some of the effect of Argentina on Chile might have operated indirectly, through effects on Brazil. The chapter also finds evidence of shift-contagion, which began in July 2001, intensified in August, and had vanished by end-2001. The market interest rate differential is found to have influenced the exchange rate in the expected direction, but the effect of copper prices on the exchange rate is unclear.

4. The considerable volatility of the price of copper is a matter of special relevance for Chile, where copper accounts for more than a third of exports and profits from a state-owned copper company are an important part of government revenue. Furthermore, the government has in place a new target for the structural fiscal balance that includes an adjustment for copper price fluctuations. Since copper prices recently have been very low—by historical standards—it is important to ask whether a substantial price recovery is likely. The chapter “Forecasting Copper Prices in the Chilean Context” finds that it is possible to forecast medium- and long-term copper price movements with some success, even using simple models based only on the past history of copper prices. Comparison of the out-of-sample forecasting performance of several models, along with other evidence, suggests that the price of copper is indeed subject to temporary—though rather long-lived—shocks.

5. Chapter III interprets the evidence as being consistent with the basic logic of Chile’s new fiscal policy regime, but cautions that there will remain considerable uncertainty over the level to which copper prices may be converging, as well as how long a given temporary price shock will last. To put this uncertainty in quantitative perspective, the chapter presents a set of simulations, illustrating implications of various scenarios for Chilean fiscal policy. The chapter also analyzes prices from the copper futures market, demonstrating that these have predictive power, and presenting a methodology through which available 2¼ year futures prices might be used to infer market expectations over longer horizons.

6. In light of both the deceleration of growth and the external shocks faced by Chile during the last few years, the staff took a closer look at the Chilean banking system. Chapter IV, entitled “Chile’s Banking System Soundness,” reports prudential, profitability, and efficiency indicators as well as the results of stress tests conducted by staff in late 2001.

7. Chapter IV finds that bank capitalization continues to be adequate and the proportion of the system’s loans that are overdue has remained stable at low levels. Net after-tax income also improved during the year, reflecting gains in net interest inflows, reduced requirements for constituting loan-loss provisions, and continued increases in efficiency. The stress tests (which used the August 2001 balance sheets as a base) computed for each bank the net losses resulting from shocks to interest rates, to the exchange rate, and to loan quality. After each shock, the Basel ratio for each bank was re-calculated. It was found that in most cases, the majority of the banks continued to meet the minimum capital requirement established in the Basel Accord. The chapter also reports the long-term foreign and local currency credit ratings by domestic and international ratings agencies. The ratings present a picture of a stable banking system with the four largest banks displaying some of the highest ratings.

8. Chapter V, entitled “A Note on the Corporate Sector’s Potential Vulnerability,” provides a brief overview of Chile’s corporate sector’s structural characteristics and seeks to identify potential vulnerabilities by looking at the evolution of balance sheet and cash-flow indicators that have been useful to predict financial distress in other countries. These indicators include measures of interest cover, leverage, liquidity, and profitability. The chapter also examines the corporate sector’s foreign exchange exposure.

9. The results suggest that the financial position of Chile’s corporate sector is sound overall, with no evident sign of vulnerability and limited exposure to foreign exchange risk. The time profile of some of the indicators considered also suggests that this position was even stronger in the mid-1990s, except for the foreign exchange exposure, which appears to have decreased in recent years. The chapter also explains some of the limitations of the analysis, and calls for further work on these issues.

Chile: Selected Issues
Author: International Monetary Fund